Open letter by outgoing OPEC Secretary-General Ali Rodriguez

Jul 07, 2002 02:00 AM

The following open letter was sent by outgoing OPEC Secretary-General Ali Rodriguez to ministers attending the 26
June extraordinary conference in Vienna on fundamental challenges facing the organization and the oil industry in the
producing countries.

Excellencies, friends and colleagues, Two special sets of circumstance have inspired me to share some reflections
with you.
The first is my response to the decision reached at the Consultative Meeting of our Conference in Cairo last
December, to outline the new realities and challenges facing the international petroleum sector.
And the second relates to my recent -- unanticipated -- appointment as President of PdVSA, since this means that I
can no longer maintain a permanent and direct dialogue with you, a longstanding practice from which I have benefited
enormously.

As we all know, among the new realities, one can find such phenomena as the environment, epitomized by the Kyoto
Protocol, the new rules governing world trade, through the World Trade Organization, the mergers of major
international oil companies (IOCs), and so on. All these factors are obviously connected with the oil industry and
thus are worthy of our attention. Nevertheless, we have to focus our analysis on the future of OPEC, which is linked
to the future of market share and, with it, the future of prices and member countries’ (MC) oil revenue.
I appreciate that many of the topics, on which I shall comment below, are already well known to you. However, the
reasons for bringing them to your attention now are to lend historical support to some of my reflections and to
provide the base for my conclusions, which I leave with you for your further consideration.

There is no doubt that OPEC is a unique organization. Founded in 1960, on the initiative of five oil-exporting
developing countries, OPEC was welcomed by neither the IOCs nor their home countries, i.e., the major consuming
countries. During the organization’s first decade, the IOCs insisted on dealing individuallywith each member
country, which had granted them concessions, and refused to acknowledge the very existence of OPEC. They only entered
into collective negotiations with OPEC in 1971, with the backing of their governments, at a time when the world was
about to confront a major energy crisis.
The existence of OPEC was then finally accepted, in practice at least, and albeit reluctantly. OPEC is now 42 years
old, and today it is the most important regulatory body in world petroleum markets.

Before OPEC came into being, there was not only a world petroleum market, but also a thoroughly structured and
regulated one. The necessity to stabilize prices was a tenet that had developed over many decades in the US, the
country in which the modern petroleum industry found its origins in the mid-19th century. The fact was that oil
markets were highly unstable, crashing with a frightening frequency.
In the 1930s, the problem within the US was solved by resorting to prorationing, i.e., the regulation of production
by state authorities, the most famous of these being the Texas Railroad Commission. Moreover, the regulatory bodies
of the principal producing states were organized at a federal level in the Interstate Oil and Gas Compact Commission,
which set monthly quotas for the member states. Last but not least, the system was completed internationally with the
‘informal’ co-operation of the big IOCs, which controlled production in the most important oil-exporting
countries.

The system worked very well for 30 years, and the world enjoyed stable oil prices with an overall upward trend.
However, in the 1960s, cracks began to appear. On the one hand, US production lost continuously in importance as a
percentage of world output, because new discoveries were concentrated increasingly in some dozen or so of Third World
countries, and demand grew fast.
And, on the other hand, the big IOCs had to face competition, and were less and less able to control production in
these countries. The only way to maintain the system would have been to formally incorporate the governments of the
exporting countries into a scheme of worldwide prorationing. However, the IOCs and the consuming countries deemed
this unacceptable Instead, because of the strategic importance of domestic oil, the US resorted to a system of import
quotas.

World petroleum markets were divided into two parts: The US maintained its traditional domestic price level in
accordance with the cost of its marginal wells, whereas, in the rest of the world, prices were allowed to fall. Not
surprisingly, this was unacceptable to the oil-exporting countries. It was, at this point, that OPEC was
founded.
For OPEC’s Member Countries, oil was of even more strategic importance than it could ever be for the US, due to
the extremely high proportion of these countries’ export revenue that came from sales of petroleum in world
markets.

The reason not to allow the exporting countries to join the existing scheme of worldwide prorationing was simple: The
big IOCs’ ability to manipulate production was their most potent weapon to discipline these developing
countries individually, whenever they tried to introduce some changes in the concession system of colonial
vintage.
By 1960, these countries were no longer happy with the level of royalties and taxes the concessionaires paid. That
was the time of 50-50 profit-sharing agreements. But, if one takes a closer look at these agreements, 50-50 was
actually the outcome of paying both royalties and income tax at the same rates that were applied to marginal
production in the US. Hence, the most prolific oil lands of the world, located in the exporting countries, were
subject to the same level of taxation as marginal lands in the US. Not surprisingly, the IOCs enjoyed profit rates of
between 50 and 150 %. The governments of the exporting countries rightfully felt that this did not constitute a fair
deal.

Thus OPEC was founded with two well-defined goals:
1. to re-establish one price structure in world petroleum markets, and
2. to get a fairer share of profits.
We all know that OPEC failed in the 1960s, at least with regard to market prices, which continued to fall. One may
also argue -- although this is more debatable -- that OPEC failed to increase royalty and tax rates.
But the fact is that OPEC’s bargaining power was sufficient to prevent the IOCs from again adjusting posted
prices to falling market prices, as they had done before. And royalties and taxes were paid on the basis of posted
prices! Hence, in spite of falling prices over that decade, fiscal revenue per barrel did not fall, and even
increased slightly. Consequently, profit-sharing evolved in the 1960s from 50:50 to 75:25, in favour of the exporting
countries.

The MCs were also successful in setting up national oil companies (NOCs), which played an important role in new
upstream contracts. These contracts were always more advantageous to the governments than the old ones, and they all
had in common the fact that, on top of royalties and taxes, there was participation in equity.
Moreover, to acquire such participation also in the older concessions became an important part of OPEC’s policy
which was summarized in 1968 in the Organization’s Declaratory Statement of Petroleum Policy in MCs (OPEC
Conference Resolution XVI.90). With participation, OPEC had found an evolutionary approach to sovereignty, at a time
when MCs were still too weak to claim, in an outright manner, their sovereign rights. With increasing participation
in equity, MCs would have control over growing volumes and also, ultimately, market prices.

The resounding success of OPEC in the early 1970s was the product of long-term trends. Apart from the geological and
economic facts already mentioned, there was also the inexorable move towards the independence and sovereignty of all
Third World countries. Moreover, newcomers were steadily eroding the power of the big IOCs. Hence, when the US
Government froze domestic prices in 1972, after all the surplus capacity in that country had disappeared and prices
had begun increasing sharply, the IOCs were no longer able to extend the freeze worldwide, as they had done on
previous occasions.
By the same token, OPEC and its MCs could no longer be prevented from advancing along the lines of their Declaratory
Statement. The old concession system disappeared, as the MCs fully asserted their sovereign rights. These rights
included the right to regulate production, taking over this responsibility from the US and the IOCs. And the NOCs
took over the old concessions. OPEC’s advance took the consuming counties completely by surprise.

Therefore, the organization was initially in an exceptionally strong position. However, the world of oil was no
longer united by one hegemonic power. Instead, it was divided into two parts: the natural resource-rich exporting
countries and the natural resource poor importing countries. The latter, however, included the developed consuming
countries, with their abundant economic, technological and political resources.
And, with the benefit of hindsight, we all know that OPEC was able to resist everything but the temptation of higher
prices. At the end, there was the verdict of the market: the price levels of the late-1970s and early-1980s were not
sustainable. OPEC’s direct approach to pricing also proved to be too rigid. There followed the price collapse
of 1986, and the evolution of the system of OPEC quotas which definitively replaced price-setting.

Prices would, and could, never be as stable again as in the past, because they were now the outcome of a tug-of-war
between the exporting and importing countries. However, over time, prices may have become somewhat more stable,
because investors everywhere have ‘settled in’, in accordance with their long-term expectations.
Hence, the present OPEC price-band may be seen, hopefully, as the result of a converging process. But we cannot be
complacent about this. Our Research Division must continue to carefully scrutinize the short-, medium- and long-term
outlook for the market, to enable OPEC to react in a timely manner to any significant change in expectations in the
world economy or advances in technology, affecting the demand for oil. Our strength is rooted in our exceptional
natural resource endowment, but this would serve no purpose if we were unable to maintain a reasonable market share.

The division of the world of oil into two parts also entailed the development of two kinds of investment and fiscal
regime. Within OPEC, royalty and income tax rates were increased, and the NOCs cooperated with governments in
maximizing fiscal revenue. Our governments generally collect, in royalties and taxes, a very high percentage of gross
export revenues In contrast, in the consuming countries, in an unfettered effort to maximize output, the fiscal and
investment regimes have evolved in the opposite direction. Most notably this can be observed in the British North
Sea. This no longer has an NOC, and today only some modest vestiges of special petroleum taxation still
survive.
This policy, backed by the governments of the big consuming countries, is of particular importance, because the IOCs
are being allowed back into some exporting countries. The British North Sea is their reference case, and their
governments and international consultants back them. The consuming countries, moreover, have strengthened the
bargaining power of the IOCs through bilateral or multilateral investment treaties. In spite of their name, they
actually cover all kinds of upstream contracts, although they never mention -- a revealing fact -- natural resources.
Upstream contracts are simply qualified as ‘investment agreements’.

And, last but not least, to implement their policy, the IOCs are engaged in a strategy of
‘agency-capturing’ i.e., a strategy to convince first the NOCs of their common interest in paying less in
royalties and taxes, and then, in turn, to use these NOCs to convince their governments of this, arguing that higher
volumes would compensate for lower revenue per barrel.
This strategy has been successful in the case of some of the weakest exporting countries. In the long run, its
success would result in significantly lower prices and, above all, significantly lower -- and even disappearing --
fiscal revenue from oil, beyond the minimum defined by normal non-oil taxation.

At the time OPEC was founded, we were all subject to the same concession system and the same fiscal regime, and we
had to deal with the same IOCs. This fact made life much easier when it came to ‘the co-ordination and
unification of the petroleum policies of MCs’. In a sense, half the job had already been done by the IOCs, and
we only had to do the other half to elaborate a common response to our common problems.
Today, the realities facing the MCs and the other producing countries are much more diverse. We have NOCs that are
subject to different governance structures, with a great variety of corporate cultures and subject to different
fiscal regimes. Even greater are the differences in the relationship andtreatment of private investors, especially in
the more recent past, but overall there is a worrying trend towards ‘softer’ fiscal regimes. Some
governments have also reacted to, and negotiated individually, bilateral or multilateral investment treaties, which
support this trend.

The consuming countries and IOCs have been quite successful in picking the weakest exporting countries, one by one,
and imposing on them new sets of rules designed to weaken their capacity to defend their specific interests. Needless
to say, this also weakens all exporting countries and, ultimately, OPEC.
At present, then, ‘the co-ordination and unification of the petroleum policies of MCs’ demands a major
effort in communication. The diversity we observe today in MCs is, of course, largely a necessary one, the
consequence of the independent, sovereign development of each country.
But, when it comes to the underlying principles of the petroleum policies of the exporting countries, our common
interests are today as importantas they were 40 years ago. Above all, we are unanimous on the principle that all
countries are entitled to use their natural resource endowment as a lever to national development. They all have the
right to regulate accordingly access to their natural resources, in the interests of promoting their economic,
political and social development. This is directly through, say, Leontief multipliers and favouring national
entrepreneurship, as well as, indirectly but certainly no less importantly, through the collection of special fiscal
revenue, especially in the case of exhaustible natural resources.

Hence, we should be able, for example, to elaborate on a common position regarding the minimum fiscal revenue to be
collected, even on the marginal barrel. The IOCs and consuming countries believe that this minimum should be zero.
They do not believe that there is such a thing as a free meal, but nevertheless they have come to believe, or want us
to believe, that there should be such a thing as a free barrel! There is the more complicated issue of the role of
NOCs in upstream contracts.
Are they business partners in these new upstream contracts, or are they acting on behalf of their governments as
natural resource-owners? These are two very different issues, and they should be very clearly distinguished because
confusing them entails, as recent experience tells us, poor business practices and, perhaps worse, perverse political
practices.

New realities have developed over the last few decades, and OPEC has had to face new challenges. Our fundamental
principle, ‘the coordination and unification of the petroleum policies of MCs’, is today as valid as it
was 42 years ago. This requires, however, a renewed effort at the highest level -- perhaps a new ‘strategic
committee’, to start with -- with support from our Secretariat in Vienna and its highly qualified staff.
Beyond quotas and prices, which we have learned to manage successfully, are the question of market shares and, most
importantly, the question of fiscal and investment regimes which require a new assessment. I have no doubt that we
will be able to cope with the new realities and the new challenges now, as successfully as we have done in the past.

It is with these reflections that I must formally -- and sadly -- bid farewell to you, my esteemed friends and
colleagues, in my official capacity as Secretary-General. Prior to my appointment to this post, I also had the
privilege of participating in our Conferences and other high-level meetings, as Minister of Energy and Mines of
Venezuela, as well as OPEC President. Venezuela, I am proud to say, is a founder member of OPEC and, today, retains
the same high level of commitment to the ideals and the practices of the organization as it did in the formative
years of the 1960s, the pulsating years of the 1970s, the dire years of the 1980s and the resurgent years of the
1990s.
I should like to thank all of you for the friendship and the support you have shown me since the late 1990s, as I
have sought, to the verybest of my ability, to carry out my assigned mission, in the interests of Venezuela, OPEC and
the world at large, so as to ensure that there is an equitable, stable and orderly international oil market.

The International Affairs Institute (IAI) and OCP Policy Center recently launched a new book: The Future of Natural Gas. Markets and Geopolitics.

The book is an in-depth analysis of some of the fastest moving gas markets, attempting to define the trends of a resource that will have a decisive role in shaping the global economy and modelling the geopolitical dynamics in the next decades.

Some of the top scholars in the energy sector have contributed to this volume such as Gonzalo Escribano, Director Energy and Climate Change Programme, Elcano Royal Institute, Madrid, Coby van der Linde, Director Clingendael International Energy Programme, The Hague and Houda Ben Jannet Allal, General Director Observatoire Méditerranéen de l’Energie (OME), Paris.

For only €32.50 you have your own copy of The Future of Natural Gas. Markets and Geopolitics. Click here to order now!